Global Telecoms: Key Themes For 2017

BMI View : Regulatory, competitive, macroeconomic and technological pressures will again be the main forces shaping the global telecommunications industry in 2017. Although our core outlook is one of 'business as usual', we acknowledge that the steady replacement of globalist economic planning with more localised 'populist' approaches to driving economic development and diversification will colour investment decisions in the short to medium term, despite the fundamental borderless nature of the industry.

The United Kingdom's decision to withdraw from the European Union ('Brexit') and the election of Donald Trump to the US Presidency were the two landmark events of 2016. Although neither development individually has a direct impact on the global telecoms industry (Trump's intentions to put an end to the US's net neutrality experiment notwithstanding), we believe the impact of these events on the global economy and on the world's financial markets will force investors in infrastructure and services to adopt more considered strategies over the next two years, shoring up any weaknesses in their existing business models as they do so.

In short, a more prudent and more pragmatic approach to investment will be seen and this will benefit consumers and local economies as much as it will players' balance sheets. It will be vital that regulators use this opportunity to develop tools that will minimise investment wastage; in particular, mechanisms aimed at deriving more value from existing and future infrastructure would give telecoms companies the confidence to invest in services end-users actually need (and which they will pay for).

During 2016, AT&T agreed to buy Time Warner, Facebook and Twitter began offering streamed sports content, narrowband wireless Internet of Things (IoT) solutions such as Sigfox began to proliferate and telecoms operators moved to take control of Connected Cars' dashboards (with mixed success). Meanwhile, Netflix went global, spending more on dollar content per subscriber than it will recoup in the long term. Consolidation of fragmented wireline broadband/TV markets accelerated in Eastern Europe and Latin America in 2016, a trend that will continue to play out in 2017. And governments worldwide will continue to make spectrum available for bandwidth-hungry operators (some being more mercenary than others in valuing these assets).

In 2017, developed markets investors will need to navigate fast-changing regulatory and consumer trends with care. In emerging markets, identifying the optimal solutions to energise expansion will be the main challenge, as always.

In summary, the key global themes for 2017 will be:

Going Beyond Pure Connectivity: Convergence And OTT To Drive New Service Development

Rationalisation Of Investment: Focusing Only On What Is Needed

Consolidation: Players To Seek Greater Scale

Regulators Will Need To Catch Up With Market And Technology Advances

Childhood's End For IoT: Time To Grow Up

Going Beyond Connectivity

Netflix set the bar high for over-the-top (OTT) video services in 2016, making good on its promises to operate globally by launching in multiple new markets worldwide. It was followed by Amazon, which invested heavily in new TV shows and content of its own, most notably the automotive entertainment show, The Grand Tour (which, arguably, transcends traditional language barriers). Local broadcasters and existing subscription video-on-demand services will increasingly respond in kind in 2017, but few have the scale to compete with the global giants in the long term. We can expect to see multiple casualties in the years ahead.

Returns on investment in streaming video will be highly elusive as players will struggle to raise prices to help offset content creation/purchasing costs. In addition, the wide range of platforms on the market means that quality content will be hard to come by and will be spread across different platforms. Arguably, no single service provider can have universal appeal in every household and consumers will be forced to choose between just a handful of platforms. Netflix's launch of a downloadable content service and AT&T's launch of a streaming variant of its DIRECTV service in December 2016 show that even the biggest and most successful OTT players are struggling to find ways of fully monetising their businesses.

Nevertheless, it is clear that convergence of traditional and new wave services is a highly desirable route forwards for industry players and we expect to see operators invest heavily in advanced next-generation network (NGN) infrastructure that will enable them to either offer their own branded OTT services or partner with OTT service providers. Where they lack the scale and resources, they will acquire complementary or rival businesses and we anticipate no let-up in the pace of consolidation in 2017. Most acquisition targets will be small or unlisted players, so an upside to this process is that market fragmentation - a key barrier to broadband adoption in less developed markets - can be corrected, bringing more customers and dollars to the market.

See:

'DirecTV NOW: Not The Netflix Of Live TV', November 30 2016;

'Traditional Pay-TV Under Pressure From VOD Platforms', November 28 2016;

'Sports Not The Only Way Twitter Can Increase User Engagement', November 18 2016;

Part of the problem in achieving timely return on investment is that the cost of deploying new technology or acquiring additional resources such as spectrum is very high, yet competitive pressures conspire to subdue income growth dynamics. Over the last five years, operators have been working together to reduce costs on the infrastructure side, either through joint network buildouts, sharing key network elements or pooling assets in jointly or independently-owned companies. We expect this trend to continue in 2017 and anticipate an acceleration in tower sales/spin-offs; this would be welcome news for specialised towers companies, particularly in Europe where such developments are long-overdue.

We also believe operators will be monitoring developments at Telxius, Telefonica's newly-created infrastructure business, with a view to undertaking similar asset separations of their own or selling to Telxius itself, should that be the new company's desired strategy.

For the most part, however, operators will continue to invest in proprietary bricks and mortar, deepening the reach of their 3G/4G networks, deploying fibre-to-the-home/building/cabinet (FTTH/B/C) where it is commercially viable to do so and employing new wireless broadband technology such as small cells and low power/wide area solutions to address the growing market for connected 'things'. That is not to say that operators will be any more forward-looking and ambitious than they are at present: we still see considerable investment directed towards 'life-extending' solutions for older technologies, such as VDSL/vectoring for copper local loop infrastructure, G.fast for both copper and fibre and DOCSIS 3.1 for cable.

We anticipate regulators needing to take a more proactive role in forcing asset-rich incumbents to open up their next-generation networks to alternative players, although heavy-handed interventionist practices should be avoided where possible.

2016 was characterised by a number of large billion-dollar mergers and acquisitions, most notably Altice's purchases of Suddenlink and Cablevision as well as TPG's purchases of RCN Telecom and Grande Communications. These came in the wake of Charter Communications' acquisitions of Bright House Networks and Time Warner Cable and AT&T's purchase of DIRECTV and were driven by the purchasers' need for scale to insulate themselves from falling ad spend as well as 'cord-cutting' driven by the expansion of OTT services. In light of AT&T's offer for content producer/broadcaster Time Warner - which could drive content prices up - we expect further consolidation to occur in the video-centric US market, with MediaCom and CableOne both considered to be prime targets for Altice.

Elsewhere in the world, the need for scale to justify investment in OTT and advanced broadband services is also driving consolidation, but just as often it is dictated by the desire to move into new value-added services markets, such as enterprise connectivity. In emerging markets, such as Sub-Saharan Africa and Eastern Europe, players are either looking to expand and enhance their most profitable core markets or seeking out new opportunities in ancillary markets such as mobile financial services (MFS) and e-commerce, as well as smart city and connected car services. IT service provision is also becoming a must-have offering for telecoms companies that have been ceding ground in this field to specialised players.

Impediments to consolidation include the reluctance of regulators to allow larger deals to go through. Many agencies still adhere to outdated notions that a market can only truly be competitive (and, therefore, 'good for consumers') if there is an optimal number of providers. To an extent, this is still the case, and there are several markets in Latin America, the Caribbean, the Middle East and Asia where efforts should be made to attract new players to the market. We believe Liquid Telecom will be particularly focused on moving into West Africa during 2017.

However, in an industry where breadth and quality of service is a better barometer of competitive well-being, blocking mergers simply to ensure that a certain number of players is maintained is counter-intuitive. This is exacerbated in instances where one of the merging parties is already in a weak position and where prolonging its existence is an exercise in futility. Also, demanding that assets be hived off from merging parties to facilitate the entrance of a replacement player rarely works. We have a dim view of Iliad's chances of success in Italy, where it will fill the void left by the merger of 3 and WIND, simply because it will be under-resourced relative to its peers, while the successful price-orientated market-disruptive strategy will not translate well in Italy.

See:

'CYTA Sale The Catalyst For Consolidation End-Game', November 15 2016;

'DISH TV-Videocon D2h A Defensive Move At Best', November 14 2016;

'Phonero Buy Crystallises Telia Refocus Views', November 8 2016;

'Broadband Behind Cable Consolidation', August 17 2016;

'CWC Merger A Boost For LiLAC', June 7 2016.

Broadband And Bundling Driving US Consolidation

US Broadband Market Forecasts

e/f = BMI estimate/forecast. Source: FCC, BMI

Regulators Need To Catch Up With The Times

Few regulators have the tools or the experience to properly oversee the smooth functioning of modern electronic communications service markets and we believe there should be a concerted effort by these agencies to catch up in 2017.

Retail and wholesale service regulatory toolkits generally continue to see little distinction between infrastructure and service businesses and treat all players equally, even those that are based externally and have no physical infrastructure that can be used to measure their ability to influence a market. The AT&T/Time Warner deal provides an excellent opportunity in this regard. Time Warner's extensive content production and distribution business gives the telco unprecedented power over the content market, potentially putting smaller operators at a cost disadvantage. However, the FCC's remit to cover the media market is limited and there is little crossover with its telecoms regulatory toolkit.

The FCC itself can be considered unfit for purpose in the broadband era, where it has singularly failed to promote or develop competition at the market or state level; in many parts of the US, choice is limited to one provider and where such providers' own traffic/services are increasingly being sidelined by external network-agnostic service providers, the Obama administration's efforts to promote net neutrality have been met with hostility. President-elect Trump has signalled his opposition to the concept of net neutrality and his plans to appoint anti-neutrality commissioners to the FCC pose a threat to Facebook, Twitter, Netflix and AT&T's OTT services amongst many others.

Elsewhere, regulators have struggled to force dominant players to fully open their markets to competitors. The incumbents argue that, in order to safeguard sustainable infrastructure investment, they should not be required to sell access to advanced networks cheaply. Some - like Deutsche Telekom and BT - have focused on 'good enough' incremental technological improvements (VDSL, vectoring, G.fast) at the expense of future-proof connectivity such as fibre. In Germany, BNetzA's efforts to force Deutsche Telekom to open its networks are slowly bearing fruit, but UK-based Ofcom's decision to enforce relatively light 'legal separation' of the Openreach networks business from BT does not go far enough.

In Latin America, we expect regulators to make better progress with regards to releasing unused spectrum for mobile broadband purposes (particularly frequencies in the 700/800/2500MHz bands), as well as rolling out mobile number portability in countries that currently lack such tools (Bolivia is one example), rationalisation of licensing regimes to ensure operators can choose the best technologies and services that suit their business models (eg: Brazil), the elimination of complex price caps (Costa Rica) and collaboration on regional issues such as mobile termination and interconnection rates.

The nascent Internet of Things (IoT) market took further steps towards maturity in 2016 and this process will continue in 2017. We forecast almost 40bn 'things' will be connected to the Internet by 2050, with cars, homes, clothing, medical devices (and medicines) leveraging connected technologies to varying degrees.

Telecoms companies have a vital role to play in the IoT ecosystem of the future, but their current business models see them trying to position themselves as integrated access and service provider, which we believe is not sustainable (even though it is certainly desirable). Few of today's telecoms companies will have the flexibility of approach needed to develop IoT applications for a broad customer base and we believe they should focus on services and solutions if they are to fully monetise this opportunity.

Our 'operator-as-a-service' vision of the future telecoms market sees infrastructure and service as two different commodities best exploited by dedicated players in these respective fields, but that state is a long way off and, in the interim, we foresee players working both independently and with third parties to hone their IoT capabilities. In 2017, we expect to see operators invest heavily in both pre-5G technology as well as interim solutions such as low power wide area broadband technologies such as Sigfox. Italian telecoms towers companies have embraced the concept of small cells and focused wireless broadband as a means of adding value to their infrastructure businesses, further validation of our championing of Operator-as-a-Service.